By Simon Gray – The impact of the global financial crisis and economic downturn upon the alternative fund industry is reflected in a more difficult fundraising environment and new challenges for managers such as greater regulation and increased investor demands for transparency, according to leading providers of administration, legal and brokerage services to funds and their managers.
These developments have led to a shift from standardised products and industrialised processes toward greater service flexibility and customisation, the firms say. Off-the-shelf structures are frequently giving way to individualised investment solutions; service providers are moving away from centralised, often ‘offshored’ operations in favour of smaller units that are closer to the client both geographically and in the way they work.
These changes are particular pertinent in the fund administration sector, according to Peter Hughes, managing director of Apex Fund Services, who says his firm’s focus on establishing offices and delivering services in the jurisdictions where fund managers are located improves the level of service Apex can provide, through better understanding of the clients’ business, problems and needs.
“Over the past three or four years we have been travelling the world to find out what fund managers are looking for,” Hughes says. “We have more than 20 offices around the globe wherever there are fund management communities. Being close to clients enables us to receive feedback at first hand and to adapt to managers’ requirements. No matter where they are, how big their fund is or what their strategy is, we can provide appropriate solutions and do so locally.”
The human factor is vital in delivering highly personalised services to clients. “It comes back to having good people in our offices that can delivering the work locally and understand our clients’ business,” he says. “For example, the managing director of our Shanghai office knows how to route money into and out of China in legal ways that we can share with potential clients. That kind of local expertise is not something you can expect from an administrator of Chinese funds based in Ireland.”
Hughes adds: “Our strategy is to obtain a better understanding of managers’ business and what they need to grow. It’s no good just churning out NAVs without considering clients’ situation and their particular needs. We are trying to add more value in the services we provide, because that is how we develop our own business. If the funds get bigger, we get paid more. Everybody’s interests are aligned.”
This is particularly important, he argues, because of the difficulties faced by many managers, especially new businesses, in an environment where fundraising remains long and arduous. “When there isn’t much liquidity around, as has been the case over the past couple of years, it’s about finding the lowest cost ways for people to set up funds, create a track record and start building a business,” he says.
Ultimately, Hughes believes, finding ways to help the asset management industry to thrive in the new environment is a more productive approach for administrators than cost-saving strategies that may entail trade-offs in terms of service quality. “Some of our competitors are more focused on ways to save costs and make their business more efficient than on giving good client service,” he says. “Staff working out of a low-cost centre in India will probably not be aware of what clients are looking for. Such firms may not be interested in providing out-of-the-box solutions; instead clients have to fit into the box that they offer.”
Increasing regulation is an added complication. “That’s inevitable, and it’s what shareholders are insisting on after their experience over the past few years,” Hughes says. “They are the ones with the capital to invest, so fund managers have to respond by delivering what they are asking for. That may mean products in more regulated jurisdictions such as Malta, Luxembourg and Ireland, and more retail-friendly types of fund such as Ucits, which tick most regulatory boxes but are the most onerous to operate.”
According to Hughes, the biggest fear of the asset management industry is that the wave of new regulation will stifle growth and innovation by creating insuperable barriers to new entrants, but he believes administrators can mitigate the risk by helping managers to adapt to the changes at a cost they can afford. “We are examining ways to provide systems that enable our clients to meet those requirements without incurring huge costs, which is what they are afraid of,” he says.
The increased take-up of Ucits structures as a vehicle for hedge fund strategies has been boosted by uncertainty over the eventual implementation of the European Union’s Alternative Investment Fund Managers Directive, which will take effect from around mid-2013. Although the framework of the directive was agreed last November after more than 18 months of at times heated debate between EU member states, industry members are still uncertain about the shape of the detailed subsidiary legislation and regulation that will spell out how the directive will work in practice.
“The full impact of the AIFM directive is not yet clear because it still has to be interpreted by different jurisdictions,” says Andrew Dollery, who is responsible for origination and structuring at prime broker Newedge. “Up to last November, offshore managers were concerned about whether they might be shut out of the EU market, and what would happen to US managers marketing into Europe. Some of those questions have been answered, but Ucits structures continue to attract plenty of demand.”
Dollery believes that the comfort managers and investors have with the long-established and highly successful Ucits brand will ensure continued robust demand from the hedge fund community, despite the introduction of the European ‘passporting’ facility under the AIFM Directive. “There is more than EUR6trn in Ucits funds today, which has built up over the past 25 years,” he says. “Hedge funds have been dipping their toe into the water for the past two or three years, and there is now quite a lot of momentum behind the structure within the community. It will continue to grow, it’s not a fad.”
Paul Farrell, a Dublin-based partner in the global investment funds group of law firm Walkers, says that investors and managers are more keen to go down the Ucits route, despite its greater investment constraints, than into regulated onshore alternative fund products such as the Irish QIF or Luxembourg SIF. “If they can fit their strategy within the Ucits regime, they will do so,” he says.
“The most important driver is that Ucits offers huge distribution opportunities. Not only does it bring a European passport, but Ucits funds can now be registered for public sale in up to 70 jurisdictions across the world. It is a truly global mutual fund that works almost everywhere but the US. Another driver is that Ucits is a settled regime. People are unsure as to how the AIFM Directive will work out, but if they can fit their strategy within Ucits, they do not have to worry about that.”
An example of how the industry is becoming less commoditised and more bespoke is that start-up managers have become much more open-minded about the jurisdictions and structures they use, according to Farrell’s London-based colleague from Walkers’ global investment funds group, Deborah Poole.
She says: “We’re seeing a steady increase in single-investor products used by family offices to manage the family wealth where different members are in different jurisdictions around the world, and they need a mutual, flexible structure to hold their assets. In addition, trustees are using single-investor fund structures in an effort to minimise their fiduciary risk when they bring in third-party experts to manage particular assets.”
Hughes insists that service providers must be ready to accommodate the needs of managers whatever their preferences. “We are completely agnostic about which jurisdiction they use to because we cover all jurisdictions,” he says. “We are not trying to force them down a particular path. A firm that only had operations in Cayman and Luxembourg might say that Luxembourg is the best place to go in Europe whereas Cayman is best if you’re going offshore. By contrast, we can give completely objective advice designed to help the manager become as successful as possible.”
A further complication for the industry is the new rules on the role and responsibilities of a fund’s depositary that will be brought in by the AIFM Directive (and are set to be replicated in Ucits V, the next iteration of the directive). However, Farrell argues that the situation could have been even worse had the proposals suggested in early drafts of the directive been adopted.
“The change in depository liability in the directive was very important,” he says. “Otherwise depositaries would have almost been in the position of insurers to the funds for which they provide custody, and the cost of setting up funds in Ireland or Luxembourg would have gone up considerably. As it is, Irish-based custodians are lobbying to ensure that the detailed rules contained in Level 2 measures will not affect the industry too significantly.”
The revised directive will still see custodians take on greater responsibility for losses incurred by alternative funds through fraud or negligence, but they will not be subject to strict liability irrespective of how they have performed their safekeeping duties. Farrell notes that in part the initial draft of the directive appeared to have been a reflex response to the issues highlighted by EU-based feeder funds that channelled investors’ capital to Bernard Madoff’s massive Ponzi scheme: “It was a reaction to the situation where Madoff was appointed as a sub-custodian to funds in Luxembourg and Ireland and investors lost out.
“Custodians must do proper due diligence on entities they are proposing to appoint as sub-custodians, and if they fail to do so, they may be liable. But it’s going much too far to hold a depositary responsible for all the actions of a sub-custodian; insurance-type arrangement are not appropriate for these types of fund. That would force a lot of players out of the market and make it more difficult for managers of small and start-up funds.
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